In problem 2.6, you drew two different AS supply curves, based on the sensitivity of inflation to the output gap. The following graph shows a curve that is sensitive to inflation changes (AS1) and a curve that is less sensitive (AS2):

a. Draw an AD curve and assume that the equilibrium point represents the long-run equilibrium point.
b. Suppose that a housing boom takes place. Show the effect on AD and explain how the short-run inflation and output response are different in the two cases.

Transcribed Image Text:

AS AS2 Output gap, (percent deviation from potential GDP)